The Silent Paradigm of Deflation

What does economic deflation mean to you?

As I’ve gotten more interested in macroeconomics I’ve spent a ton of time trying to mentally model how inflation or deflation could potentially manifest in everyday terms. How could it change the course of your life or the course of your country’s development? So much of this seems high minded and likely beyond a normal individual’s control (much of it is), but leaving the hard thinking to the academics and people in power is a great way to get collectively steamrolled by historical events as they unfold with little to no effective ways to react or prepare.

What I’ve come to believe as I’ve researched this subject and tried to relieve my ignorance over the past 3 years of crisis has led me to believe that contextual thinking about inflation or deflation can be broader than just beyond what you’re paying for groceries or gasoline.

In this piece I want to scratch the surface of how I’ve learned to think about the phenomena of deflation versus the more commonly discussed subject of inflation, and how I have so many more questions now than I did when I started my learning journey a few years back. 

Capitalism is like fire - we need it. Full stop. But when we play with it too much one way or another beyond its ideal nature, we can wind up in a lot of trouble. 

To follow this analogy, we’d all agree the fire in a fireplace is pretty useful - roasting marshmallows, cooking your dinner, warming your body, etc. You’ll freeze to death in short order without fire, you can’t cook, you can’t do a lot of things. So is more fire better or less fire? Too much wood, too much propellant, and you suddenly have an out of control blaze that burns your house down. Too little fuel for the fire and it goes out. In the fine balancing act that surrounds all of civilization, the art is in moderation versus anarchy and entropy.

The skilled fire tender knows what they need from the fire and work to maintain it overtime and may even have some tools to rescue the situation from calamity one way or another if things get out of control. Luckily (?) we have central bankers who monitor just how fire-y (hot) the economy is using lots of data ingested throughout markets. It is largely considered the responsibility of the US Federal Reserve (The Fed) to keep the rate of inflation and deflation in check as well as the unemployment rate moderated using a variety of tools at their disposal. Assuming these tools at the disposal of these official work as intended, countries like the USA who issue their own sovereign fiat currency should be able to navigate the ups and downs of macro cycles and proceed with growth in most cases. 

At least that’s been the reality for the last 50 years or so since the last great inflation and another 100 years since the last great deflation. In the long arc of time it’s easy to assume that the time we’re living in and the trajectory we’ve been on for some time is enough of an indicator to believe not much should change in the future. But assuming that would make us fools of randomness, which we may be naturally anyway. Human nature makes us have short memories along with being so innovative over time. Let’s be honest - paradigms have shifted since we’ve been able to record them - why would that stop now? 

Our (Old) Friend Deflation

Defining Deflation: Deflation is when consumer and asset prices decrease over time, and purchasing power increases. (source)

Inflation is the topic du jour these days and it’s easy to at least think about how it affects you - higher prices, right? Ask yourself - what do you think about its inverse concept of deflation? 

What is deflation and how does it materially represent a way of life for a society? In pop culture the macroeconomic condition that gets the most coverage and scares the most is inflation. The phenomenon is usually related to inflationary events in history related to failed states, world wars and massive population loss on a scale that destroys nations. If inflation means in layman’s terms (which I am very much in the camp of), too much money chasing too few goods, does deflation equal too little money chasing too many goods? What does that mean for you and I? 

In the cult of personality behind many macroeconomics thinkers, being an inflationist is certainly a way to excite your followers and depending which angle you come at it from you can even create a brand on how to hedge against inflation and (maybe) make money during it. 

This is not the case with deflation. I’ve noticed in my own learning that deflation is hardly talked about not because it’s an unlikely outcome, but because there are few if any ways to make money during deflation through the spectrum of economic classes. Everyone loses to deflation - but to varying degrees. It’s just not sexy to hedge against deflation based on what I see in the media. However that does not mean it’s not worth exploring how to lose LESS than normal during a deflationary cycle. 

About 100 years ago the United States and global economy at large experienced a great bout of deflation which we currently understand as the Great Depression. Whether you’ve spoken to elders who may have lived through part of the Great Depression or read about it in history books - there are a few common symptoms that probably come to mind. Those include mass unemployment, bread lines, stock brokers jumping out of Manhattan skyscrapers and general economic misery that persisted throughout most of the 1920’s. 

Does any stock market crash, increase in unemployment or increase in poverty signal true deflationary tendencies? I’m not sure about that. Do declining demographics and quantum leaps in productivity growth make for deflation? Sure, they may contribute to it, but on the other side of those arguments are geopolitical, economic, social and financial factors that just may wind up tipping the outcome in unexpected ways. 

I truly don’t want to say that I believe or know for sure that inflation or deflation is in our future - the smartest people in the world argue about this and there’s no 100% consensus view besides that the world is evolving at a more rapid pace than ever before and I just don’t want to blindly want into the future without having as much useful knowledge of economic paradigms as possible. 

I want to give myself a high five here as one of my favorite macroeconomists Luke Gromen gave me a shout out and answered my questions about deflation in his latest video here - and I have to say I really do agree with his point of view. I personally see inflation forces in the long term being more prevalent in my lifetime, but it’s good to know that I’m not the only one suspicious about potential deflationary outcomes in the short term. 

Some deflation insights I’ve learned a ton from:

• Jeff Schneider (Eurodollar.university) 

• David Rosenberg (Rosenberg research)

• Kyla Scanlon